Last-minute dealmaking in the tax-exempt market is forcing sellers to lower prices if they want to make a trade as the year wraps up.
“We’ve had buyers but they aren’t buying everything,” a trader in New York said. “If it’s cheap enough, they will.”
Some traders “don’t want stuff on the books that they’ve had on there for a while, so they are cheapening to get them off the books,” he said. “If they get to a certain level, they will sell.”
A trader in New Mexico said he wasn’t necessarily participating in forced selling. “Some people are wanting to buy, but their bids are too low, so we’re sitting tight and just watching,” he said. He added that he would rather keep his position than give bonds up cheaply.
Munis were steady across the curve, according to the Municipal Market Data scale. The two-year yield closed flat at 0.36% for its 14th consecutive trading session. The benchmark 10-year yield held at a record low 1.91%, as recorded by MMD last week. The 30-year muni yield remained flat at 3.63%.
Treasuries were mixed, with yields on the short end rising and yields on the long end falling. The two-year yield rose one basis point to 0.30%. The benchmark 10-year yield fell one basis point to 2.02% while the 30-year yield fell two basis points to 3.04%.
In the primary market, the negotiated calendar is empty, with no deals scheduled for an expected quiet week between Christmas and New Year’s. The competitive calendar expects a paltry $5.9 million in new long-term issuance.
In the secondary market, most trades reported by the Municipal Securities Rulemaking Board were flat, but a few trades showed firming.
Bonds from an interdealer trade of California 5s of 2032 yielded 4.34%, seven basis points lower than where they traded the previous week.
Bonds from an interdealer trade of Massachusetts Development Finance Agency 5.2s of 2031 yielded 4.21%, two basis points lower than where they traded the week before.
Muni-Treasury ratios finished down for the week, with the five-year and 10-year ratios closing below 100%. The five-year finished at 92.9% and the 10-year closed at 94.1% last Friday. The 30-year ratio finished down for the week, but still above 100% at 118.2%.
“Lack of new issues and strong demand are pushing munis to outperform Treasuries as the year comes to a close,” wrote Alan Schankel, managing director at Janney Capital Markets. “There is nothing on the horizon this week to change that calculus.”
Looking back, falling yields prevailed for most of 2011, according to BondDesk Group. The year started off with a strong reaction to Meredith Whitney’s prediction of a massive wave of defaults, which triggered unprecedented outflows from municipal bond mutual funds.
“This was the most clear-cut example of retail individual bonds behaving differently than mutual funds,” said Chris Shayne, senior market strategist at BondDesk. There was a massive increase in retail demand for individual muni bonds during that time, he said.
Yields were temporarily elevated due to heightened fears early in the year, but fell continuously after that to the lowest yields since January 2006, Shayne said.
“As soon as frothy price dislocation and rampant fear vacated the muni market over Whitney’s comments, yields started to stabilize and progressively drop,” Shayne said. “And they dropped pretty consistently the entire year until bottoming out in September, and then they just went sideways.”
Spreads were mostly flat until August, but they began to rise after the U.S. debt ceiling standoff in Washington. Spreads finished 2011 higher than at any point since January 2006, with the exception of the 2008 financial crisis.
In terms of demand, 2011 was a year of extremes. Demand spiked in January and February, when buying activity was over 20,000 traders per day, the highest in three years. Then, with a combination of summertime malaise and low yields, demand fell to a three-year low, 13,653 trades per day in September. It was the only time in three years that trading activity has fallen below 14,000, BondDesk said.
“In January 2011, we saw the highest trading volume at any point in the past three years and by September of the same year, we saw the lowest trading volume in three years,” Shayne said. “So we had both the high and low of trading activity. It was a year of extremes.”
Looking forward to 2012, Shayne says he is looking at the disconnect between yields and demand. Usually, the two are highly correlated — higher yields usually mean high demand will follow. With extra low yields, demand usually wanes.
But in November, yields languished and were pretty close to the lows of the year, but demand jumped. Shayne noted that in October, there were 14,784 trades per day, but demand jumped in November to 15,947 trades per day, and yields were mostly unchanged in that time period.
“Why would demand increase when returns haven’t increased?” Shayne said. “Our conclusion is that equity market fatigue appears to be setting in. People are tired of volatility and munis are the antithesis of that. There were a few high-profile defaults in 2011, but at the end of the day, it’s a sleepier, safer place to invest.”
Shayne also doesn’t expect yields to go much lower in 2012. BondDesk tracks median yields over the entire spectrum of munis, including all types of credits and all durations, and the median yield generally does not fall below 4.00%. When Treasury yields fall, spreads have historically widened to fill the gap to maintain a 4.00%.
“Presumably, we’re going to trade sideways or go up from here based on historical patterns,” Shayne said. “Historically, no matter what Treasuries have done, spreads have widened enough to maintain that median level between 3.90% and 4.00%.”